For each case below, you are the trader on the opposite side of the trade witlh

Question

For each case below, you are the trader on the opposite side of the trade witlh me at time to(0). For each case below, state the trade you will perform with me at time to0) For each case, you must explain the reason for your trading decision In all cases, both you and I begin with a portfolio of zero (no cash, no stock, options, etc.). 1. Money required to buy things must be borrowed from me. Interest must be paid on the loan. Money received by selling things is loaned to me. I will pay interest on the savings 3. The borrow and lend interest rates are equal. Both are equal to the risk-free rate 4. There is no limit on the quantity to buy or sell anything, including short selling of stock. 2. In all the cases below: I. The current value of the stock price is So = 100. 2. The stock does not pay dividends. 3. For questions involving a stock index, the current value of the index is 1000 points. 4. The stock index has a continuous dividend yield of 1.5%. 5. The interest rate is 5% (borrow and lend rates are equal). . All the options have the same expiration time of 1 year . All the forward/futures contracts have the same expiration time of 1 year

Explanation / Answer

Answer 1)

At time t0 I will have long position.

Answer 2)

Reason for Trading:

As it is stated that the given stock does not pay dividend, therefore the only way to make profit is through price variation. The potential gains in a long position are unlimited as the share price can increase many times over. But the potential loss is limited to 100% - a complete loss of the initial investment- unless the position is financed by borrowings. In this case the loss will be more than 100 % (Principal + Interest) as I have to finance the investment through debt (as given in the question) but still it will be much less than the losses incurred in short selling.

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